The LBO model works as follows: a PE fund contributes equity (typically 40–50% of total capital) and arranges bank and/or private debt (50–60% of total capital) to fund the acquisition. The acquired company services the debt from its operating cash flows over a 4–7 year hold period. At exit, the company is sold at a higher multiple or larger EBITDA base — and the PE fund generates returns from the combination of EBITDA growth, multiple expansion, and leverage (debt paydown increasing equity value).
The IRR (Internal Rate of Return) is the PE fund's primary return metric. Most mid-market PE funds target 20–25% IRR over a 5-year hold period. At 20% IRR over 5 years, a €1 invested must return approximately €2.49 (2.5× Money-on-Invested-Capital, or MOIC). Understanding the IRR model helps sellers calibrate how much the PE buyer can pay: if the buyer expects to sell in 5 years at 9× EBITDA and needs 20% IRR, the entry price is mathematically constrained. Sellers who know the buyer's return model can have a more sophisticated price negotiation.
For French and Swiss SME founders, the most practically important implication of LBO financing is the effect on post-closing flexibility. The acquired company must service debt (principal and interest) from its cash flows — reducing the cash available for investment, bonus payments, and other distributions. Vendors loans and earnouts are additional obligations on the same cash pool. A founder who agrees to a high earnout on top of a highly leveraged deal should understand that the earnout may not be achieved simply because the debt service consumes the available cash.
LBO return model
Entry: EV €20m at 9× EBITDA (€2.2m). Financing: €12m debt (60%), €8m PE equity (40%). Exit year 5: EBITDA €3.5m at 9× = EV €31.5m. Debt repaid to €7m. Equity at exit: €31.5m − €7m = €24.5m. PE equity invested: €8m. MOIC: 3.1×. IRR over 5 years: ~25%. This is a successful LBO if the growth assumption is achieved.
Frequently asked questions
What is the maximum leverage a PE buyer can use for a French SME acquisition?
For French SMEs in the €2–10m EBITDA range, typical senior bank leverage is 3–4× EBITDA at closing — limited by bank appetite and, for some, by Bpifrance guarantee conditions. Private debt / unitranche lenders may allow 4.5–5× EBITDA. Total debt (senior + junior) rarely exceeds 5× EBITDA for non-recurring-revenue businesses; software/SaaS with high ARR can support higher leverage.
How does LBO leverage affect the purchase price a PE buyer can pay?
Higher leverage allows the PE fund to deploy less equity for the same enterprise value — improving equity returns at a given exit multiple. But leverage is constrained by the company's debt capacity (its EBITDA relative to interest and repayment obligations). A business with thin EBITDA margins or volatile earnings cannot support high leverage — limiting what PE can pay. For robust, cash-generative SMEs, PE leverage capacity often exceeds what the seller expects.
Should a founder prefer a PE buyer over a strategic buyer?
Depends on priorities. Strategic buyers typically pay more (synergies), offer cleaner exit (less post-sale involvement), and have simpler structures (no debt service to worry about). PE buyers offer rollover opportunities (second bite), may want the founder to stay and lead, and provide a more structured transition. For founders who want a full exit and maximum price, strategic buyers usually win. For founders who want continued involvement and a second upside event, PE can be compelling.